New Issues Stand in Foreground of Big Picture for ‘90s
On Wall Street, just as in real life, the day-to-day headlines usually wind up being far less important than they first appear. What really counts is the Big Trend.
Lately, the day-to-day market headlines have been dominated by two stories: the surge in stock prices (and with it a spate of new stock offerings by capital-hungry firms) and the continuing struggles of seemingly countless debt-laden companies--from Continental Airlines to Orion Pictures to First Executive Corp.
You may not be interested in buying a new stock issue from, say, Regeneron, an up-and-coming biotech company. And you may not care whether Orion Pictures survives to release “More Dances With Wolves.” But if you invest or think you may sometime this decade, the Big Trend here is important--that is, the new rise of equity (stock ownership) and the decline of debt.
As the accompanying chart shows, 1984 through 1990 was an astounding period of stock disappearance. Companies borrowed like mad to take over other firms or to buy back their own shares. The result was that more stock was removed from the market than was issued each year, while corporate debt soared.
In 1988, $126 billion in stock was taken away. In the same year, the net debt issuance of non-financial companies topped $150 billion. It was fashionable to be in hock and equally fashionable to go into debt to buy up someone else’s cheap stock--or your own.
Imagine that you’re back in 1983. If you had known then how dramatic the shrinkage of equity would be from 1984 to 1990, you could have made a pretty good bet on the stock market--that prices would rocket as debt fueled a wave of takeovers and leveraged buyouts.
Now the trend is poised to reverse. Companies are flooding the market with new stock, and investors increasingly are as eager to buy as they were to sell to takeover bidders in the ‘80s. Debt, meanwhile, is still issued as well, but only by the most financially sound companies and often to refinance older debt at a savings.
Stock is what’s getting people’s attention again. John Lonski, economist at Moody’s Investors Service in New York, notes that though last year showed a net disappearance of stock--$63 billion--that was half the 1989 total.
Could the urge to buy shares actually put stock-issuance back in the positive column this year, for the first time since 1983? “I think we’re on that track,” Lonski says.
RJR Nabisco, taken private in 1989 in the biggest leveraged buyout of all time, is perhaps the best-known symbol of the debt-to-equity movement. It will sell 75 million new shares to the public this month--its second stock offering this year--and use the proceeds to cut debt.
For investors, savers, entrepreneurs and others, the key issue is whether one can see ahead to the broader implications of this equity Big Trend and profit from them--as you might have if you were prescient enough in 1983.
There are three basic questions here: Why are companies so willing to sell new stock today, why are investors so willing to buy it and, most important, can this last for years, not just months?
From the companies’ point of view, Goldman, Sachs & Co. analyst Steven Einhorn notes that it’s worth selling new ownership because stock prices have finally risen above the underlying per-share value of corporate assets. In the 1980s that mostly wasn’t true, so selling new stock would have been selling yourself at a discount. You were better off borrowing if you needed cash.
Investors, meanwhile, also have come full circle. They aren’t willing to take chances anymore on high-yield junk bonds, so that market is dead.
Interest rates on other bonds, such as Treasuries, have fallen with the recession, so returns there have become miserly. Short-term interest rates are a joke at 6%.
That leaves the stock market as perhaps the lone route to making money.
This seller-buyer embrace is still a tenuous one, however. Stocks will have to keep rising to entice more firms to sell shares and cut debt. But does it make sense to believe that prices can go up even as the supply of stock balloons?
Einhorn argues that it does. Historically, he says, “there have been many periods when shares were rising and stock issuance was significant.” The 1960s, for example.
The great risk, of course, is that interest rates will soar again. Higher rates would throw the equity-debt equation out of kilter. “Long-term bond yields will make or break the equity market right now,” Lonski agrees.
That’s why, to believe in a corporate equity Big Trend in the ‘90s--and a rising stock market with it--investors have to believe in another equity Big Trend: their own. If, as individuals, we get serious about saving more, cutting debt and consuming less, we may foster a moderate-growth economy with potentially little upward pressure on interest rates.
Admittedly, that will be a difficult dance. Growth will have to be slower, yet fast enough to keep corporate profits healthy, thus underpinning stock prices.
Can we pull it off? As a nation, we almost have to. The rest of the world--Eastern Europe, the Soviet Union, Kuwait, South America--needs capital even worse than we do. If we can supply more equity to American companies, and they use that capital to strengthen themselves by expanding their markets and making investments worldwide, everybody should win.
On the other hand, if this emerging Big Trend fails, the cost will be much greater than just what happens to stock prices.
